Credit Cards and their affect on Household Budgets

Credit card expenses refer to interest payable on credit card liabilities, any annual standing charges, and any other additional surcharges. As per a 2013 report from Aviva, credit card was the most popular source of borrowing with 39% of households preferring a credit card over personal loans and overdraft.

Credit card expenses in detail

Credit cards are used for different reasons such as purchases, transferring existing debt, or for earning reward points and cashback. Let's look at the different types of credit cards.

0% interest: These cards are suitable for those who want to make purchases on credit and repay back within the allowed time limit. There is no interest on purchases for a specified period as long as you are paying the minimum monthly amount on time.

Example 1:

As of September 2014, Halifax is offering a 0% interest on purchases for 20 months. The minimum repayment is 1% of the debt plus any fees for missing payments or for exceeding the credit limit. The card does not have any annual fee. The representative APR or interest is 18.9%. As long as you pay your monthly instalments on time, you don't have to worry about APR till the end of 20 months. So if you purchase a new mirrored wardrobe from Argos for £239 using this card, you will not have to pay interest for 20 months as long as you pay the minimum amount due every month. However after 20 months, you will have to start paying interest on the outstanding loan at an APR of 18.9%.

Cashback and reward points: Apart from credit, these type of credit cards provide rewards like cashback, reward points, or air miles, on purchases. Over a period, these cards can be very rewarding for heavy spenders.

Example 2:

American Express Platinum Cashback Everyday Credit Card offers a cashback of up to 1.25% on annual purchases above £7,501. The cashback is 0.5% on purchases from £0 to 3,500, subject to a minimum of £2,000 worth of purchases. On purchases between £3,501 and £7,500, the cashback is 1.0%. Suppose, you have already made purchases worth £2,000 in a year and you want to buy the £239-wardrobe from Argos, you will get a cashback of £1.19 if you purchase it using this card. To be eligible for this card your household income should be a minimum of £20,000. There is no annual fees on this card, and the representative APR is 19.9% per year.

Balance transfer: Balance transfer cards are useful for transferring your existing debt to a lower rate of interest. This card can help you in saving your interest expenses.

Example 3:

Barclays is offering a 0% balance transfer for 34 months at a one-time fee of 2.99%. So, if you have an existing 0% interest card for say 15 months, and you are nearing the end of the 15-month period with an outstanding of say £2,000, this card can be very beneficial. The card can provide savings of up to £777 over 34 months. Let's say your debt of £2,000 is going to be charged at an APR of 19.8%. If you transfer a balance, you will have to pay a one-time charge of £59.8, but you can save on interest expenses for 34 months.

Minimum amount due

This is the minimum amount you need to pay every month to keep your account active and also to avoid paying a higher rate of interest. The minimum amount depends on your monthly spending, your APR or interest rate, annual maintenance charges, if any, and whether there are any surcharges such as delayed payments. Typically the minimum amount is a fixed amount or a certain percentage of your total liability.

Example: The Barclays card listed above charges a minimum amount of the highest of either of three amounts -- £5, or 2.25% of the total amount owed, or 1% of the remaining balance plus interest and maintenance charges.

Your debt can be repaid over a period simply by paying the minimum amount, but it can be very expensive. You will end up paying a lot more in interest and also it will take years for the debt to be paid off. That is why it is best to pay some amount over and above the minimum amount every month.

Credit card expenses as part of your household budget:

Apart from the flexibility of payments and other benefits, credit cards also provide other advantages such as improvement in credit score if you make repayments on time. However, you need to be wise and restrict interest payments to a minimum by repaying the debt regularly. Else, the interest liabilities can shoot up and have a negative impact on the household budget.

Our household budget calculator can be a useful resource for calculating the role of credit card expenses in your household budget.